Federal Leases ..................................................................................................................
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rivate developers continue to show a strong
interest in using the capital markets to finance
construction, or refinance existing mortgages by
using federal lease payments as security. However,
credit quality on these transactions can vary widely
depending on the contractual, lease-term, and struc-
tural provisions of the lease. Standard & Poor’s
Ratings Services rates transactions that are backed
by lease rental payments from several different U.S.
agencies. Although all of these structures are
secured by lease rentals paid by the U.S. govern-
ment, some transactions carry more risk. Reflecting
this risk differential, the rating distribution on these
issues ranges from ‘AAA’ to ‘BBB’, with the prepon-
derance occurring at the ‘AA’ level.
Most federal lease agreements are not structured
with a public debt financing in mind. Each federal
lease has different features and needs to be evaluat-
ed on a case-by-case basis. Most prominent in
many of the federal lease transactions is the risk
associated with the involvement of an unrated
developer as lessor. To mitigate the developer risk,
Standard & Poor’s requires that the lessor be a sin-
gle-purpose corporation or limited partnership
(SPE) with restrictions on future indebtedness and
its operations limited to the leased property. Please
refer to Standard & Poor’s criteria on SPEs for
more detail. In addition, Standard & Poor’s will
require a non-consolidation opinion between the
SPE and its principals. However, significant devel-
oper risk exists with the construction and operation
of the facility. Four key areas that should be care-
fully evaluated are:
■Appropriation risk;
■Structural risks;
■Cash flow risks; and
■Construction risk.
As with municipal leases where the lease extend
for the full term of the bonds, the most important
factor in determining credit quality is the govern-
ment’s obligation to make lease payments subject to
the government’s access to the facility, as well as the
lessor’s successful performance of all of its obliga-
tions under the lease. This is defined as the appro-
priation risk. Certain government leases do not
carry the appropriation risk in that the government’s
obligation is absolute and unconditional, subject to
the terms of the lease. If this is the case, an opinion
will be required from the agency’s general counsel’s
office stating that the lease rental payments are gen-
eral obligations of the U.S. government, backed by
its full faith and credit. As long as the construction,
structural and cash flow risks associated with the
contract have been full mitigated, such obligations
will carry a rating of AAA.
There are two other types of appropriation risk
that federal leases carry. In some instances, the obli-
gation to make lease payments is subject to
Congress making an appropriation to the agency
for a specific function, such as military housing.
Under this scenario, the military department is obli-
gated to make the lease payment if Congress appro-
priates any funds to the agency for housing military
personnel. The only way the military department
would not be obligated to pay is if Congress appro-
priated the funds for military housing and included
specific language stating that the specific lease or
class of leases were not to be paid. The essentiality
of the function to the government is important.
The second type of appropriation risk is that of
the congressional line item. This type of appropria-
tion is more visible and would undergo a very strin-
gent analysis of essentiality. Risks associated with
the congressional line item appropriation involve
not only the funding of specific governmental pro-
grams but also the importance of a single site to the
delivery of services provided by the program. Since
demographics and cost structures change over time,
it could have an impact on where and how the gov-
ernment wants to provide services.Structural Risk
The lease structure governs the environment under
which the government’s lease payments are made.
There are four basic elements that could have an
impact on credit quality:
■The match of the lease-term to the term of the
debt obligation;
■Lessor obligations under the lease;
■Rent off-set rights by the government; and
■The government’s termination rights under
the lease.
Historically, the term of a federal lease has
matched the term of the debt obligation. However,
this has recently become the exception rather than
the norm due to increased federal budgetary pres-